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Group No: 08
A Comprehensive Study on Dell’s Working Capital
Prepared for:
Prepared by:
Group No: 08
Department of Finance
University of Dhaka
SL No Name ID No Remarks
Dear Madam,
We consider ourselves very fortunate to prepare this report under your valuable guidance.
Working for this report was both a challenge and pleasure to us. We are indebted to you.
Your suggestion of the topic of our report “Dell’s Working Capital” was very appropriate. Your
constant guidance helped us to apply our theoretical acquired in the classroom to the practical
world.
Thank you for giving this kind of challenging task.
Sincerely yours
Khalid
19/09/2020
………………….
Shaikh Saifullah Khalid
Id No: 23-160
On behalf of Group 08
Table of Contents
Executive Summary .................................................................................................................................... i
Case Synopsis ............................................................................................................................................ 2
Problem Identification ............................................................................................................................ 2
Options ..................................................................................................................................................... 2
Analysis........................................................................................................................................................ 3
Question 1: How was Dell’s working capital policy a competitive advantage? ......................... 3
Question 2: How did Dell fund its 52% growth in 1996? .............................................................. 6
Question 3: Assuming Dell sales will grow 50% in 1997, how might the company fund its
growth internally? How much would working capital need to be reduced/ or profit margin
increased? What steps do you recommend? .............................................................................. 10
Question 4: How would you answer to question no 3 if dell also repurchases $500 million of
common stock in 1997 and repaid its long-term debt?............................................................... 11
Recommendations ................................................................................................................................... 12
Conclusion ................................................................................................................................................. 12
Works Cited ............................................................................................................................................... 13
Appendix 1: Pro Forma Financial Statements of 1996...................................................................... 14
Appendix 2: Pro Forma Financial Statements of 1997...................................................................... 15
Appendix 3: Pro Forma Financial Statements of 1997 with Share Repurchase and Debt
Repayment ................................................................................................................................................ 16
Executive Summary
Of all the creators of shareholder value in the 1990's, the most dramatic have been strategic
innovations, those bold new business models that forever changed the rules of the industries in
which they were applied. But in today's competitive business world, only a brilliant business
model alone does not create a sustainable advantage, unless it is implemented by operational
excellence, the continual identification and adoption of best practices.
Dell Inc’s direct sales model is one of the most brilliant strategic innovations of the past 30
years. With the simple concept of bypassing the retail channel to sell directly to customers, Dell
managed to create an unique model that beats its competitors on price, creates closer links with
customers and provides shareholders a return several times that of market averages. But Dell
faced net loss in 1992-93.
Dell discovered their limitations of a strategy based solely on growth, and of its own
management and structure. In 1993, Dell expanded their product line to include notebook
computers, but had to abruptly withdraw the ill-conceived and unreliable new machines from the
market. Dell moved partly into the retail channel, offering its products through PC superstores,
like power retailers, including Wal-Mart, Staples etc. The company grew, with sales reaching
$2.8 billion in the fiscal year ended Jan. 31, 1994, but at a net loss of $36 million.
So, in 1996, Dell shifted their focus from growth to sustainable profit, growth and liquidity.
However, Dell managed 52% growth in 1996. But, the question is how long, Dell can sustain
this level of sales growth? Dell was bypassing their sustainable growth rate significantly. So,
Dell must need to look for additional funding sources to support their sales growth.
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Dell’s Working Capital Case Solution
Case Synopsis
Over the last few years, Dell Computer Corporation has experienced continuous increases in
sales, regularly surpassing industry growth rate. In the fiscal year of 1996, Dell achieved an
impressive sales growth of 52%, relative to the industry growth rate of 31%. With industry
analysts anticipating the personal computer market to grow 20% annually over the next 3 years,
Dell is expected to continue its recent trend of strong performance. Nevertheless, inventory
shortages have limited Dell’s full growth potential these past few years. Although their build-to-
order inventory system has resulted in an incredibly efficient asset turnover, this strategy also
limits the company’s sales when consumer demand exceeds the supply of inventory on hand.
Problem Identification
Dell is facing inventory shortage due to their strict ‘Build-to-Order’ production model. Moreover,
Dell is outpacing their sustainable growth rate (32%). So, Dell needs to implement appropriate
working capital policy to support their growth (52%).
Options
Dell has several options to maintain their growth rate.
Maintaining current working capital policy
Financing future growth internally
Financing future growth externally through equity issue and borrowing
Financing growth through both internal and external sources
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Dell’s Working Capital Case Solution
Analysis
1
We are assuming same COGS amount for both Dell and Compaq
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reduction, inventory loss will be 2.61% for Dell and 6% for Compact. So, comparative
increase for Dell’s net profit in 1996 is equal to 1996’s Dell’s net profit times the
difference between Dell and Compaq’s inventory loss which is$9.22 million.
iii) Dell’s Build-to-Order model: The industry practice back then was to make forecast
of sales units of computers and making computer or assembling the components
based on the forecast. The problem was that no one could actually predict the future
or make a reasonable guess of the computer industry back then given the industry is
growing at an unprecedented rate which is in some years in negative figures and
double digit growth from year to year. From the situation described in the case no
single year of industry growth can be traced with a forecast, for instance, the growth
in 1991 was negative and a single digit growth next year which is at 7% rate. After
the 1992, the growth took double digit rate and most interesting thing happened next
year where the growth rate doubled within a year. So, every single competitors of the
industry was forecasting the future sales and manufacturing computers based on the
forecast
The Dell Computer was managing working policy in a different way. They were a
small company back in 1990s. They had been fearing the ongoing consolidation
trends of the industry and opted for a different inventory management policy. They
adopted the build to order model which yielded low finished goods and low work in
process inventory balances. The idea of build to order model was to build the
computers after receiving the orders instead of manufacturing or assembling the
computers before and waiting for the buyers and selling receiving the orders. The
motive behind that was to keep less cash or near cash balances tied up in the
inventory so that they can eventually survive the ongoing industry consolidation
trends in early 1990s.
If we want to check the industry scenario of early 1990s, Compaq, Apple and IBM’s
finished goods inventory typically ranged from 50% to 70%. In contrast, the Dell
Computers finished goods and work in process inventory ranged from 10% to 20%,
which was more than fivefold lower than the industry average.
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Dell’s Working Capital Case Solution
So, how did policy change serve as a competitive advantage for Dell Inc?
Companies operating in the computer manufacturing industry back in 1990s used to
maintain high levels of inventory to stock resellers and retail channels. As a
consequence of that, they had to bear additional costs to maintain high levels of
inventory and inventory soaked up additional working capital which can be used to
foster additional growth.
Dell was making computer based on orders from the customers. As a result, they
had less working capital tied up in inventory and work in process goods. So, they can
continue their business with lower than average industry working capital and can
instantly respond to the market needs.
The policy paid off greatly in 1995 when Dell became the first manufacturer of the
industry to convert its major product line to the Pentium Technology. Because of its
low finished goods inventory, Dell didn’t have to reconstruct their computer inventory
when a major flaw of intel process got attention and they could readily respond to the
situation as they didn’t have high levels of finished and working in process inventory.
iv) Sourcing Components on daily basis: Apple, IBM and Compaq, all top three
computer manufacturer had high levels of working capital tied up in inventory. Back
then, processor chip comprised about 80% of the cost of a PC. The truth about the
technology market as a new technological improvement takes place the prices of
components fell by an average of 30% a year. As the top shareholders of the
computer manufacturing industry had high levels of inventory in their working capital,
they had to deliver computers with older technology as they had to clear the existing
computers made with older technology.
But the reality was totally different for Dell Computer. As they used to collect
components of computers from the suppliers in daily basis, they did not have to
deliver computers with older technology. So, they can deliver what customers
wanted instantly.
Because of that, Dell became the first manufacturer of the industry to convert its
entire major product line to the Pentium Technology and achieved volume production
of systems with the new 120 mhz processor. Afterwards, they equipped the Microsoft
Corporation’s new Windows 95 on the first day of launch.
So, Sourcing components in daily basis helped Dell Computer to bring new
technological improvement in the market at the shortest possible time.
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Dell’s Working Capital Case Solution
There were a couple of fundamental changes that effectively had direct impact on the growth of
Dell Computer in 1996. To name a few, we would like to mention the combined shift towards
liquidity, profitability, and growth instead of previously taken initiative of only focusing on growth.
The liquidity and profitability improvement at the same time has funded the 52% growth in 1996.
In terms of profitability improvements, we would like to check a few ratios of profitability to
measure the year to year margins and returns based on various denominators.
The exit of low margin indirect retail channel had other impacts as well other than net profit
margin improvement. The Return on Assets, the Return on Total Capital and Return on Equity
had significant improvement. Only because the significant improvement in sales and net profit
margin.
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Dell’s Working Capital Case Solution
1994 92% 1% 7%
YEAR
In 1994, Dell adopted the Pentium Model processors. The sales percentage of Pentium based
processor rose two times from the year 1995 to 1996 from 29% to whopping 75%.
Dell was the first company to bring its major product line to Pentium technology in the computer
manufacturing industry, which brought the fortune of 52.4% sales growth fortune within a year to
Dell Computer.
We averaged out the quarterly cash conversion cycle numbers to measure the year to year
improvement. The average CCC was 47.5 days in 1994 and within a year it reached at 38.5
days in 1995. After that, in 1996, CCC rose to 41.25 days. We tried to investigate the possible
reason, the quarterly average DPO reduced to 40.25 days from 44.75 days, which caused the
CCC increase in 1996.
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Dell’s Working Capital Case Solution
Defensive interval ratio measures the liquidity that indicates the number days of average cash
expenditures the firm could pay with its current liquid assets. For Dell Computer, the ratio
reduced to 101.81 days in 1996, which was 120.5 in 1995. That was a sign that Dell Computer’s
companywide metrics towards liquidity and profitability at the same time working, for instance,
the company’s financial position remained liquid at the same time the ROIC rose to 35.8%
keeping the Defensive Interval ratio significantly high.
Few points on 52.4% sales growth of Dell Computer:
I. Companywide policy towards liquidity and profitability at the same time directly impacted
its growth of 52.4% keeping all of its leading metrics suitably higher than before.
II. Companywide metrics adoption to provide detailed profit and loss statements helped
make timely and data driven decision to take steps towards liquidity and profitability at
the same time.
III. Low margin retail channel exit and being the first producer to convert major product line
to the Intel’s Pentium Technology significantly contributed to the sales growth and
profitability in 1996.
IV. Sales growth could also be impacted by the new Microsoft Windows 95launch with the
Dell Computer’s System at the same day.
V. For keeping the growth and profit margin stable Dell Computer hired seasoned
managers, though their direct impact were not quantified.
We can analyze the growth funding process in 3 steps. Firstly, we need to forecast how much
funds Dell needed to sustain their growth. Secondly, we need to evaluate their sources of funds.
Finally, we need to evaluate the impact of their growth financing with their actual balance sheet
figure.
However, we need to state the assumptions of our forecasting:
Sales growth, g = 52%
Cost of sales, operating expense and other expenses/income will be increased
proportionately with sales amount.
Net working capital to sales ratio in 1995 was 18.45%. Same ratio will be maintained in
1996.
Debt ratio as a percentage of total assets in 1995 was 3.57%. Same ratio will be
maintained in 1997considering only long-term debt.
Other liabilities are considered as a part of working capital.
No dividends will be declared.
i) Total fund requirements: To determine how Dell funded its fiscal 1996 sales
growth, we need to analyze how much fund Dell exactly needed to sustain such
52.4% growth in 1996. When we compare Dell’s performance in 1996 as compared
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Dell’s Working Capital Case Solution
to 1995, the Sale grew from $3475 million to $5296 million reporting a growth of
52.4%. However, the total assets in 1995 were $1594 i.e. 22.01% of sales and net
working capital investment which is about 18.45% of sales. Thus, when the sales
grow by 52%, total assets need to grow in a similar proportion of sales.
Given the working capital ratio and fixed asset investment ratio as percentage of
sales Dell investment needs were $397.8 million.
ii) Sources of funds: Dell can manage their funding from two sources: internal and
external. Let’s see how much fund, it can generate from internal / operational
activities.
Internal source: From the pro forma statement of funds 1996, we found that
Dell can generate $226.48 million cash flow from their operation.
External source: Dell can collect funds from two external sources: Borrowing
and equity issue. Dell needs to raise funds $171.32 million2 externally. If Dell
maintains the same debt ratio, (14.77% of total asset), debts will be $58.76
million and equity issue will be $339.04 million.
iii) Performance evaluation and recommendations: Based on the numbers provided
by Exhibit 4 and 5 of the case, we find that the retained earnings (net profit) come
out to be $272 million, and there is no difference in long-term debt. The $272 million
in net profit is an increase from the forecasted $227 million and can be attributed to
improved net margins from 4.3% to 5.1%. Let’s summarize their performance
indicators.
Assets Turnover Ratio 2.18 2.46 Efficiency of the firm has increased.
Current Liabilities As % of Sales 21.6 17.7 Firm managed to reduce their current liabilities.
2
External financing required can also be calculated from this formula EFN= (Total assets/sales)*Δ Sales + (Current
liabilities/sales) * Δ Sales – Forecasted sales* Net profit margin(1-dividend payout ratio) = (45.87%*1807) - (23.86%*1807)
– {5282*4.29%(1-0)} = $171 million
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Dell’s Working Capital Case Solution
Question 3: Assuming Dell sales will grow 50% in 1997, how might the company fund its
growth internally? How much would working capital need to be reduced/ or profit margin
increased? What steps do you recommend?
Several assumptions need to be made to apply the critical approach to prepare Dell’s pro forma
balance sheet and pro forma funds flow statement of 1997.
Sales growth, g = 50%
Cost of sales, operating expenses and financing & other expense will be increased
proportionally with sales growth.
Net working capital ratio will be same as 1996 (16.9% of sales) and be increased with
sales growth.
Other liabilities are considered as a part of working capital.
Fixed asset investment will be increased proportionately with sales and fixed assets
investment ratio will be 3.61% of total sales.
Debt ratio will be 10.41% of total assets which will be maintained in 1997. Considering
only long-term debt.
No dividends will be declared in 1997.
i) Total funds required: Given working capital ratio and fixed asset investment, Dell’s
investment needs in 1997 is $543 million3. From the pro forma funds flow statement,
we found that they also need $135 million4 of external financing to sustain their 50%
growth. So, their target for sustaining growth is not feasible in this model.
ii) Managing internal sources: If Dell wants to finance the external financing of $135
million internally, they can follow numerous techniques. Such is increasing net profit
margin, increasing payables turnover ratio or decreasing working capital ratio.
Profit margin increase: If Dell increases their profit margin from 5.14% to
6.14%, they can achieve $79.44 million.
Working capital reduction: If Dell reduces their working capital to sales ratio
from 16.9% to 15%, they can manage additional $150.94 million
Increasing Days Payable Outstanding: Dell could demand immediate
payment from their customers for reducing Days Sale Outstanding (DSO). As
they were becoming a giant in personal computer space, they could demand
increased payment terms from their suppliers that will eventually increase
Days Payable Outstanding (DPO). The combined effort could turn the Cash
Conversion Cycle (CCC) negative that will increase cash in company’s hand,
which can be used to fund growth.
iii) Recommendations: Dell can manage financing internally by changing these two
ratios. However, Dell should not finance from particular one source only. They can
use their funds equally from these two source or three sources. Relying on only one
item such as changing the profit significantly can damage the market reputation of a
high growth company like Dell.
3
Appendix 2
4
Additional Fund Needed= (Total assets to sale ratio)*Δ Sales – (CL to sales ratio)*Δ Sales – Forecasted sales*NPM*(1-
d) = (40.55%* 2648) – (20.53%*2648) - (7944*5.14%) = $135.7 million
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Dell’s Working Capital Case Solution
Question 4: How would you answer to question no 3 if dell also repurchases $500 million
of common stock in 1997 and repaid its long-term debt?
YoY
Fiscal Year 1996 1997 Growth Change
Dell's Operating Asset 1,557 2,335.50 ∆ 1.5x 778.50
(Total Assets - Short Term Investments)
Let’s assume Dell would maintain 50% growth, repurchase $500 million common stock and
repay $113 Long Term Debt in 1997. So, the cash requirement would be –
To generate funds for that amount of cash requirement, Dell may increase its profit margin from
5.14% to 6% or higher 7%.
So, if Dell wanted to implement this strategy of repurchasing $500 million common stock, repay
$113 Long Term Debt and at the same time continue to grow at 50% rate, they need additional
$244.42 million funding in 1997 which can be satisfied by keeping lower working capital or
increasing the payment deferral period.
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Dell’s Working Capital Case Solution
Recommendations
In recent circumstances, Dell also needs external financing to support their growth. Dell should
finance their growth and inventory through the use of short-term liabilities. To be more specific,
Dell should do so by extending their payment deferral periods, which can give an interest-free
source of funding.
Also, Dell should adopt an EOQ inventory management system in order to minimize total
inventory costs, which will reduce the total amount of liabilities Dell needs to sustain their growth
moving forward.
Conclusion
Dell’s working capital analysis was one of the major issues of this case. Dell, as a high growth
company, managed to finance their growth with their operating cash flows. In 1997, Dell Inc not
only repaid their major portion of long-term debt, they also used put option as a source of funds.
In recent years, such as in 2014, they managed to reduce their cash conversion cycle into
negative figure. But computer market is always changing. One company will never be able to
grow for lifetime. Dell Inc. faced significant amount of net loss from 2014 to 2019 fiscal year.
From the beginning Dell’s strategy was built around a number of core elements: build-to-order
manufacturing, mass customization, partnerships with suppliers, just-in-time components
inventories, direct sales, market segmentation, customer service, and extensive data and
information sharing with both supply partners and customers. But nowadays Dell and other U.S.
personal computers (PC) makers are struggling to eke out a profit in an environment of falling
prices and intense international competition. The main issue for the next years seems to be
whether the cost of managing so many products might outweigh the benefits of being able to
offer products that more closely match the needs of customers.
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al_policy_a_competitive_advantage
Dong, J. (2015, November 14). Essays24. Retrieved September 15, 2020, from Browse
Essays/Business/Case Study: Dell’s Working Capital: https://www.essays24.com/essay/Case-
Study-Dells-Working-Capital/64559.html
Pandey, I. (2014). Financial Planning and Strategy. In I. Pandey, Financial Management (pp.
630-632). New Delhi: Vikash Publishing Pvt. Ltd.
RICHARD S. RUBACK. (2000, August 16). Case Hero. Retrieved September 15, 2020, from
https://www.casehero.com/dells-working-capital/
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https://studymoose.com/dells-working-capital-case-solution-essay
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